The ABC´s of Impact Investing

The field of “investments intended to create positive social and/or environmental impact alongside financial return” is expanding every day, so it’s tricky to stay up on the lingo. Here’s a list of some key terms.

Assets. Sources such as JP Morgan estimate there will be at least $500 billion in impact investments in the next ten years. The Investors´ Council of the Global Impact Investing Network (below) already includes 50 investors that each hold more $50 million in impact investment assets. Angel investors are playing a key role in developing this new market. “And.” The great beauty of impact investing it the possibility to do good AND make money at the same time. In fact, for many of the best impact investments, the more you sell, the more good you do, because the social purpose is embedded in the business model. For Vision Spring, for example, the more very low-cost eyeglass they sell, the better the organization accomplishes its mission of improving the productivity and quality of life of the poor in the developing world. For Root Capital, the more loans they disburse, the more they fulfill their social purpose of growing rural prosperity.

Benefit Corporation is a new legal structure for companies which create a material positive impact on society and the environment, consider non-financial interests when making decisions, and report on their overall social and environmental performance using recognized third party standards. Today 11 states have benefit corporation legislation and 11 more states on working it. Patagonia was the first Benefit Corp to be registered in California. B Corp certification is voluntary certification that companies have met the rigorous standards of social and environmental performance, accountability, and transparency set and reviewed by the nonprofit B Lab.

Continuum is useful way to think about impact investing. Impact Investing spans the space that lays between traditional grants to nonprofits and investments in socially responsible companies. Carbon Credits are internationally traded so that companies can offset their carbon dioxide production by funding forest carbon projects. There were $575M in voluntary carbon offsets sold in 2012. CINI (CEI Investment Notes) provides loan capital to small and micro businesses, affordable housing, community facilities, and natural resource industries that create jobs, opportunity and environmental benefits in Maine.

Debt is a common form of impact investing, including securitized and unsecuritized loans, forgivable and traditional loans. Taking on debt rather than equity can be attractive despite its expense because reduces the risk of ownership control changes which could jeopardize the mission of social enterprise. Donor Advised Funds are a traditional vehicle for making grants. Now firms like Impact Assets are pioneering holding the funds used to make those grants in impact investments.

Equity, e.g. purchasing an ownership share, is a critical piece of the impact investing ecosystem and is being included in innovative ways as part of financing packages from foundations as well as more traditional investors. For example, the Breakout Labs subsidiary of the Thiel foundation provides grants to early stage science companies in return for grants being repaid through royalties, up to maximum of 3x the grant amount, and warranties to purchase a 1% stake in the company for $.01, should the foundation be interested.

Funds of all types now offer impact investments. The Impact Assets 50 list illustrates the breadth of private debt and equity fund managers across geographies and asset classes.The full list represents $10.2 billion of capital invested in areas including community development, Microfinance (below) and clean technology.

Grants from foundations can now be made to support private companies with explicit social goals… in specific situations. The IRS has ruled that PRIs (below) can be made to L3C (below) companies. Slow Money Maine (below) has also blazed a trail for philanthropists to make tax-deductible contributions to for-profit farms and local agricultural ventures through designated donations to local economic development corporations which make such investments to further their charitable purpose. GIIN, the Global Impact Investing Network is a not-for-profit organization dedicated to increasing the scale and effectiveness of impact investing and the leader in developing standards for the industry.

Hybrid organizations fill the impact investing eco-system. Nonprofits run mission-related businesses like DKT International, which sold $76M in contraceptives and related services worldwide in 2010; private companies accomplish clearly social missions through their business operations as is the case with d.light, a company whose products, solar-powered lights, enable households without reliable electricity to attain the same quality of life as those with electricity.

International opportunities are one of the areas of fastest growth in impact investing. Bottom of the Pyramid companies, to use a term coined by C.K. Prahalad, aim to improve conditions for the world´s poorest citizens by selling them a valuable product or service at an affordable price. Investments in infrastructure in Africa, in agriculture in South America or in private schools in India can now attract investment from philanthropists and investors in the US or Europe. (Also see Kiva, below, for an intermediary for smaller donors.) IRIS, Impact Reporting & Investment Standards, are one set of standardized metrics used to describe an organization’s social, environmental, and financial performance.

J, Kiva, is a microfinance (below) nonprofit that enables individuals from wealthier countries to make loans to microentrepreneurs starting as low as $25. To date more than 800,000 individuals have made more than $360M in loans in 66 different countries with a 98.98% repayment rate. Here´s how it works.

Local investments are high priority for many impact investors. See CINI notes (above) and the No Small Potatoes Investment Club (below) for two examples. Loan Funds such as then Maine Community Foundation´s fund which made a low interest loan to the Maine Farmland Trust to facilitate farm purchases are increasingly popular. L3Cis a new legal structure in 16 states and counting which contemplates a profit-generating entity with a socially beneficial mission. L3Cs have the same liability protection as LLCs and are not tax-exempt. However L3Cs have access to forms of capital that traditional corporations don’t qualify for, such as foundation PRIs, to further their social and environmental goals.

Moo Milk is one of the best known L3Cs (above) in Maine. Microfinance organizations were some of the very first impact investment organizations thirty years ago and are huge players today. Microfinance organizations provide financial services to low-income individuals who do not have access to typical banking services. Today they serve an estimated 160 million people.

No Small Potatoes Investment Club strengthens Maine´s local food economy by making small loans to farms, fishermen and the food businesses they supply to help them thrive. This group of individual investors makes loans of $5,000 or less for low-interest with terms of up to three years without collateral. Nonprofits regularly benefit from impact investments, including recoverable grants, forgivable and/or loan interest loans and PRIs (below.)

Philanthropy, from the ancient Greek word for “love of humanity” today goes beyond the traditional concept of donations, to include impact investments. PRIs, short for Program Related Investments, are debt or equity investments made by foundations for the primary goal of furthering their charitable purpose. PRIs can take the form of a recoverable grant, loan, loan guarantee, line of credit, equity investment, or different forms of equity and count toward the foundation´s 5% minimum payout calculation. Rates of return must be below market and the foundation is exempt from the IRS´s “prudent man” investment rule.

Return on investment is an essential feature of impact investment. Investors look for, and must try to measure both the financial return on their investment and, more challenging, compare social and/or environmental returns. IRIS (see above) represents one attempt to standardize such reporting. IRIS includes potential industry metrics but there is not yet one universal standard of measurement or reporting. Individual donors/investors, foundations and nonprofits often identify their own measures of success or “impact”, measures tailored to their own priorities.

Social Impact Bonds, also called “Pay for Performance” bonds, enable governments to pay nonprofits or private provider of social services based on the results they achieve relative to targets agreed upon beforehand, results which generate identifiable cost savings to the government, such as a reduced number of incarcerated prisoners. Private investors provide the upfront funding, or working capital, to the providers in return for a potential upside (with an upper bound, for example of 7%) if performance targets are exceeded. SIBs are currently working in England and are in the process of being deployed in the Massachusetts, New York and Australia, and elsewhere. Read more about their potential here.SROI or Social Return on Investment is a framework for calculating the savings and benefits of a given social outcome in monetary terms relative to the investment outlay to achieve that result. Pioneered by REDF in 1999, SROI is also now used more broadly to talk about the benefits to society of a given investment (donation, grant or traditional investment) for a social purpose. Slow Money Mainefoster collaborations that connect investors to local food producers. Slow Money Maine participants have loaned or gifted more than $3.5M to local sustainable agriculture ventures in the last three years..

Time is key for many social enterprises to reach their potential. Many forms of impact investing are “patient capital”.

Unreasonable Institute promises to “Give world-changing entrepreneurs what they need to scale their impact”, e.g. a combination of mentoring, access to angel investors, introductions capital funds … and each other during an intense six week process. This program and many others respond to investors’ appetite for more “investment ready” social enterprise opportunities. Today there is a much larger theoretical institutional market for impact investment than there are assets invested because of the scarcity of investment grade larger scale opportunities.

Venture philanthropy, the practice of coupling significant multi-year funding for high potential mission driven organizations with non-financial contributions in the form of contacts, management advice, etc. and a focus on tangible measuring performance now includes philanthropists investing in for profit social enterprises as well as those making grants to nonprofits. According to their most recent survey, 50% of the European Venture Philanthropy Association´s members target a financial, as well as a social, return from their funds. Venture Funds specialized in impact investing, such as Grey Ghost Ventures which has more than $100 million committed to social enterprises addressing the needs of low-income communities around the world, are becoming more and more common.

Working Capital is often what social ventures need, whether they are for profit or nonprofit ventures, early stage or trying to move to a next stage. But non-traditional actors like social businesses frequently have difficulty accessing the working capital they need to grow. The impact investing sector is increasingly responding to this need, whether through products like the CINI notes (above), No Small Potatoes (above), PRIs (above), microfinance (above) loans or other vehicles.

X, Y Z…… The alphabet of Impact Investment is still being written. What else should we include in our ABCs?